How should you manage your money when you retire? Should your portfolio change when you finally sign your F.U. letter to the boss?
Is the famous 4% rule really safe or is there a better way?
While the passive path to accumulating your pension pot is well lit by blogs, books, and preachers of the gospel, the more difficult question of how to safely ration your retirement savings has no simple answer.
Attempts to supply a silver bullet to retirement spending often flounder. Proposed solutions may be unrealistic, mistranslated, too narrow, or grossly oversimplified on their journey from academic journal to custom and practice.
Michael McClung’s achievement is to survey that landscape with the rigorous eye of an engineer who wants to build a house that won’t fall down.
He’s poured his findings into Living Off Your Money. It’s a practical, safety-conscious, and evidence-based manual that DIY investors can use to avoid the retirement quicksands.
One big thing lifelong savers need to grasp as they contemplate retirement is that we become more vulnerable as we rundown our stockpile.
An unfortunate sequence of returns can put us on a crash course early on. Inflation and even the blessing of a long life can put us on prison rations in our twilight years.
The situation is worsened because traditional retirement rules-of-thumb like the ‘4% rule’ are about as reliable as ‘red sky at night’.
The 4% rule is prone to failure, numerous caveats that don’t fit into 140-characters or fewer (or even 280), and it’s barely applicable outside the US. And where the 4% rule can leave some retirees on the brink of poverty, it can leave others departing the stage with most of their hard-earned loot unspent.
The system offered by Michael McClung takes a data-forged sword to those twin-headed terrors. His design relies upon two important techniques that many retirees may struggle with:
- Dynamic asset allocation
- Dynamic withdrawal rate
Dynamic asset allocation means that your yin and yang of equities and bonds is no longer fixed by some permanent cosmic ratio. Instead, your percentages can pitch up and down depending on the motions of the market.
A 50:50 portfolio could, with McClung’s system, average between 30%-70% equities over the course of a retirement.
In extreme conditions you could end up with 100% of your portfolio in equities. Conversely when equities are storming ahead you’ll convert them into high-quality bonds, ensuring there’s fodder in the barn for when winter comes. And when equities are blown away like dandelions in a category five hurricane you’ll live on bonds until they’re gone. There’s no automatic annual rebalancing here.
With a dynamic withdrawal rate, your income rate can also vary every year.
A tempestuous retirement could see withdrawal rates swing between 2.5% and 6%. Benign conditions might bless you with an average withdrawal rate of 7.7%. When your portfolio swells, a dynamic withdrawal rate lets you spend more. When conditions worsen you batten down the hatches.
All this may make the system sound random, but it’s rather that the plan flexes in response to market feedback. It gives you a brake and an accelerator to apply rather than putting you on rails until your retirement train terminates.
If that sounds like market-timing, it isn’t.
Trial by data
Living Off Your Money builds on the work of other retirement researchers. (These guys have lower profiles than North Korean late-night comedians, and are probably only familiar to you if you’re into obscure financial planning journals.)
All have sought to improve upon the cult of 4% inflation-adjusted withdrawals plus annual rebalancing.
For his part McClung reverse-engineers their systems, tests them to within an inch of their algorithms, and then bolts together the best parts to come up with his recommendations.
The major difference between McClung and most other retirement researchers is that McClung has subjected these formulas to more tests than a talking ape.
Standard practice is to pit your proposals against the historical performance of US equities and bonds and leave it at that.
The danger is that a system that worked well when US assets outgrew those of most other nations may not look so clever when planted in poorer home soils. Even US investors may not enjoy such sunny days again. Non-US residents have no reason to expect to.
McClung guards against this by testing his contestants against the UK and Japanese datasets. Neither has enjoyed the same hot-hand as the US.
No retirement strategy trumps all others, everywhere, every time. Optimisers are missing the point – you might as well try to optimise a baby. What works in one situation won’t always work in another. McClung acknowledges this and recommends a plan that:
- Works well during historically difficult retirement periods
- Is robust across geographies
- Maximises withdrawals
- Avoids catastrophic failure like a zombie plague
- Leaves a large margin for error
He doesn’t stop there. McClung also checks his system versus the chilling effects of a low-growth world. His recommendations assume a globally diversified portfolio and performance. McClung’s mindset is world-first, not America-first, which makes his work directly applicable to UK investors in a way that most retirement research isn’t.
The Living Off Your Money strategy can also be calibrated for shorter and longer retirements. That is especially handy if financial independence is on your ‘to do’ list.
Don’t misunderstand me – McClung isn’t claiming his method is fail-safe. Very few retirement strategies would look good after a dose of German-style hyperinflation and being on the wrong side of two World Wars.
There are no guarantees, only probabilities.
There’s always a downside in investing and the trade-off demanded of you by the Living Off Your Money approach to retirement spending is that you can tolerate a volatile income and asset allocation.
Yes, you’ll probably be able to spend more over the course of your retirement. But there will be times when you’ll need to spend less. (The reality is that many retirees do naturally vary their income anyway outside of the confines of the retirement researcher’s lab.)
Sticking to the plan may also mean going all-in on equities in extreme conditions. Many retirees couldn’t cope with those strains.
To help alleviate some of these issues, McClung explains ways to take the edge off his purest prescriptions.
Floors and ceilings can be used to contain your equity allocation. There’s also an extensive section on creating guaranteed income to cover the bills when your withdrawal rate dips alarmingly low.
You may need to work longer to be able to afford such optionality. That’s the price of sleeping well at night.
Easy doesn’t do it
While McClung is a master of retirement theory, he doesn’t wallow in it. He never loses sight of his goal of creating a book that can genuinely help people.
The explanations are clear, and McClung carefully ropes off step-by-step practical sections that can be chewed on separately if you’d rather skip the methodology hors d’oeuvres.
Yet his work is steeped in integrity. McClung goes to great pains to explain his guiding principles and assumptions and – unlike some financial writers – all of his recommendations can be fulfilled in real life. There’s even a spreadsheet on his website to support anyone who wants to implement his strategy.
None of this changes the fact that reading this book and managing your portfolio by its light requires a fair degree of investment literacy.
The truth is, nobody should manage their retirement investments without a strong financial education and Living Off Your Money can help school anyone, regardless of whether you ultimately apply its teachings.
Long-term Monevator readers will be in their element. But if you just want to get by with a couple of blog posts and a few simple rules that could be printed on a tea towel then this isn’t the plan for you. Your best bet would be to accumulate so many assets that you are left with plenty of room for error.
On the other hand if you have a strong risk tolerance, genuinely enjoy engaging with investing, and want to do more with less then McClung might just change the course of your retirement.
If you’re not sure which camp you fall into then McClung has made three sample chapters available for free.
Alternatively, check Living Off Your Money out on Amazon and let us know in the comments below what you think of it.
Take it steady,